In proxy contests earlier this year involving the boards of Agrium Inc. (“Agrium”) and Hess Corporation (“Hess”), the compensation by activist shareholders of their proposed director nominees was heavily criticized both by the target boards and by third party commentators. The Agrium and Hess contests have given rise to a debate over the merits and propriety of nominee compensation generally, with some institutional shareholders and commentators calling for the prohibition of the practice. In the face of this critical commentary, the recent experience of Provident Financial Holdings, Inc. (“Provident”), a U.S. bank holding company, suggests that efforts by boards to prohibit the practice entirely are likely to meet resistance.
In advance of Provident’s annual meeting of shareholders held on November 26, 2013, the proxy advisory firm Institutional Shareholder Services (“ISS”) recommended that shareholders withhold votes against three directors who earlier in the year had approved an amendment to Provident’s by-laws that would prohibit directors from receiving compensation from anyone other than Provident for their candidacy or service as a director. Following the meeting, Provident disclosed that over 30 percent of the votes cast were withheld from these directors, a withhold vote that was far in excess of that seen in prior Provident shareholder votes.
The by-law amendment adopted by Provident disqualifies from election to the board any person who is a party to any compensatory arrangement or understanding with any person or entity other than Provident in connection with such person’s candidacy or service as a director (other than indemnification or reimbursement arrangements or pre-existing employment agreements). The by-law amendment was based on a draft by-law that the New York law firm Wachtell, Lipton, Rosen & Katz (“Wachtell”) has recommended that companies adopt in order to address what Wachtell perceives to be a threat to the integrity of the boardroom and the board decision-making process presented by independent compensation arrangements between activist shareholders and their director nominees. Wachtell proposed the draft by-law in a memorandum which was circulated in May of this year, following the Agrium and Hess experiences. According to ISS, since May, at least 25 companies in the United States have adopted similar by-laws or by-law amendments. Provident was the first of these companies to hold its annual meeting and ISS took the opportunity to address the board’s decision to adopt the by-law amendment in its analysis for the Provident meeting.
According to ISS, the by-law amendment adopted by Provident may be concerning to investors for the following reasons:
- it prohibits individuals from board service due to any arrangements to compensate a nominee during their candidacy, with only limited exceptions;
- it could deter legitimate efforts to seek board representation via a proxy contest;
- it could have the effect of excluding highly qualified individuals from being candidates for board service, thereby serving to entrench the incumbent board;
- it was adopted after a significant shareholder made Schedule 13D filings with the U.S. Securities and Exchange Commission disclosing the addition of affiliates to its group; and
- it was adopted without giving shareholders the opportunity to vote on the matter (despite the board not having been required to submit the amendment to a shareholder vote).
Although Provident’s board survived the recent vote in the face of ISS’s concerns, ISS’s recommendation in connection with Provident’s uncontested annual meeting, and the ensuing shareholder votes withheld from directors who supported the prohibition, should be seen as a cautionary note for how boards in Canada and the United States might want to think about this issue in the upcoming proxy season. While the payment of compensation by activist shareholders to their director nominees has been the subject of considerable criticism from various quarters, much of that criticism has been about the terms of the compensation, as opposed to the principle of such compensation. Accordingly, any efforts by boards to prohibit the practice outright could reasonably be expected to be resisted by both proxy advisors and shareholders and to result in votes withheld in respect of the election of incumbent directors who support such measures.